*2260 1. A valuation of the rights of one party to a bilateral contract based on promises to deliver and to receive and pay for raw material, which assumes the profit to be derived from the manufacturing business for the life of the contract based upon an estimate of the probable quantity of such raw material to be supplied, reduces such assumed profit to an average per unit of raw material, and attributes such profit to the supply contract, is unsound.
2. The opinions of witnesses as to the value of petitioner's rights in such a contract are not compelling evidence of such value when the method of reaching such opinions is fallacious.
3. Opinions as to value are not arbitrarily to be either rejected or accepted entirely but are reasonably to be weighed with all the other evidence in accordance with the demonstrated qualifications of each witness to form an opinion.
4. A contract providing for the supply of wood to which petitioner, a manufacturer of wood chemicals, became a party by assignment in September, 1912, held, on all the evidence, to have no premium value to eptitioner for invested capital or on March 1, 1913, for a basis for depreciation in 1918 and 1920.
*2261 5. In determining invested capital under section 326, Revenue Act of 1918, a bilateral contract on promises, to which petitioner became a party by assignment from another corporation, not a stockholder, may not be included as paid-in surplus, notwithstanding partial identity of the stockholders of the two corporations.
6. Special assessment denied.
*1117 The respondent determined deficiencies in income and profits taxes of $41,085.06 for 1918 and $12,639 for 1920. The petitioner claims that its invested capital should be increased by at least $800,000, alleged to be the value of a contract acquired by assignment shortly after organization in 1912, and that this figure should also be taken as the value of the contract on March 1, 1913, to support a depreciation deduction in the determination of net income of the years in question; that invested capital has been brought too low on account of taxes of 1917, and that its profits tax should be determined by special assessment under*2262 sections 327 and 328. Petitioner, in brief, abandoned a claim that alleged capital items which had been charged off as expense should be restored to surplus and thus included in invested capital. The hearing was limited under Rule 62.
FINDINGS OF FACT.
The petitioner is a corporation of Pennsylvania with principal office at Olean, N.Y. It was organized in 1912 and is engaged in the manufacture of wood chemicals.
In 1912 the Norwich Lumber Co., a Pennsylvania corporation, had rights in the timber, trees and wood suitable for the manufacture of chemicals on certain tracts of land in the counties of McKean, Cameron, and Elk, Pennsylvania. It was obligated to remove such timber, trees, and wood by 1922. It had previously arranged for the removal of wood other than chemical wood, and on June 21, 1912, it entered into a contract with the Lackawanna Chemical Co., a Pennsylvania corporation, whereby it agreed to cut all of the chemical wood on such lands and to deliver not less than 30,000 cords per year to the Lackawanna Co. at a factory to be built by the latter, at a price of $4.45 per cord, payable on the fifteenth day of the month following delivery. The contract provided, *2263 among other things, that the Lackawanna Co. should construct a chemical factory at or near Norwich, Pa., with a capacity sufficient to consume not less than 30,000 cords of chemical wood per year, and should be prepared to commence operations not later than April 1, 1913; that the contract should be assigned to a corporation to be formed under the laws of Pennsylvania with a capital stock fully paid in cash of not less than $250,000; that such corporation should not issue any bond or mortgage, or create any specific lien upon its property prior to the obligation imposed by the contract, without the consent of the Norwich Co.; that the Norwich Co. should not be liable for timber, trees, wood, or chemical wood which might be destroyed by forest fires, and, in the event of damage resulting from fire, it should not be bound to cut or deliver any wood in case the wood should be unsuitable for chemical wood, or in case the Norwich Co. after *1118 reasonable effort should be unable to contract for cutting, hauling, and loading at $3 per cord or less; and the obligation to deliver 30,000 cords per year should be reduced by the amount of wood which was eliminated from the contract by*2264 the last mentioned provisions. The contract further provided that the Norwich Co. would drill for gas and if found the Lackawanna Co. would purchase such gas for fuel and lighting purposes at 10 cents per 1,000 cubic feet. At the time the contract was made, and on September 30, 1912, the Lackawanna Co. had outstanding 1,500 shares of capital stock, owned as follows:
| Shares | |
| T. H. Quinn | 500 |
| M. F. Quinn | 489 |
| M. M. Quinn | 20 |
| E. V. Quinn | 20 |
| E. H. Quinn | 20 |
| M. J. Collins | 1 |
| F. A. Sherman Estate | 450 |
The petitioner was organized in 1912 with a capital stock of $250,000, which was paid in in cash, and the Lackawanna Co. assigned the contract to the*2265 petitioner on September 30, 1912, with the consent of the Norwich Co. The officers of the petitioner at organization and during the taxable years were, W. L. Barclay, president; T. H. Quinn, vice president; M. F. Quinn, secretary and treasurer. The petitioner's capital stock at the time of organization was owned in equal proportions by the Quinn and the Barclay families.
The petitioner commenced construction of a chemical factory at Betula, Pa., in 1912, and completed it in March, 1913. The factory had a capacity of 100 cords per day. A plant of this type is of very little value after being in use 10 or 12 years.
Quinn and his associates had had a survey made of the lands described in the contract some time about 1907.
The first delivery was made on October 8, 1912, and the last was made on October 31, 1922. The quantities delivered in each year during that period are as follows:
| Year | Cords |
| 1912 | 6,560 |
| 1913 | 40,783 |
| 1914 | 47,914 |
| 1915 | 43,381 |
| 1916 | 22,827 |
| 1917 | 23,048 |
| 1918 | 30,946 |
| 1919 | 34,157 |
| 1920 | 24,285 |
| 1921 | 69,595 |
| 1922 | 48,009 |
*1119 The number of cords of wood consumed by the petitioner, the net profit from operations, and the profit*2266 per cord realized in each of the years 1913 to 1922, inclusive, were as follows:
| Year | Number or cords | Net profit | Profit per cord |
| 1913 | 23,072 | $37,988.77 | $1.65 |
| 1914 | 28,100 | 16,294.92 | .58 |
| 1915 | 40,850 | 150,458.71 | 3.68 |
| 1916 | 42,280 | 350,536.49 | 8.29 |
| 1917 | 39,409 | 396,818.79 | 10.07 |
| 1918 | 36,387 | $208,601.58 | $5.73 |
| 1919 | 8,750 | 137,810.33 | 15.75 |
| 1920 | 25,980 | 211,846.72 | 8.15 |
| 1921 | 37,976 | 34,869.11 | .92 |
| 1922 | 41,218 | 198,398.35 | 4.81 |
There was no material change in the price of timber in this section between June 21, 1912, and March 1, 1913.
The petitioner did not set up on its books any value for the contract of June 21, 1912, nor did it show any value therefor in the balance sheets attached to its capital-stock-tax returns for 1917, 1918, and 1919, and its income and profits-tax return for 1920.
M. F. Quinn was an officer of and interested in numerous other companies during 1917, 1918, and 1920. He performed all the duties of secretary and treasurer for the petitioner, supervised the bookkeeping, and devoted the principal part of his time to its business. He was paid an annual salary of $2,000. He depended upon dividends for his compensation. *2267 No salaries were paid to the other officers.
T. H. Quinn is the vice president of the petitioner and has held that office since organization. He was experienced in the wood chemical business and in 1917 and 1918 spent about two days a week at the plant. He was also interested in two other chemical companies at that time and spent part of his time visiting their plants and looking after their affairs. He received no salary for his services in 1917 and 1918.
During 1912, 1913, and 1914 the petitioner did not pay any salaries to its officers.
In 1915 the petitioner constructed an addition to its plant which increased the capacity from 100 to 140 cords. The masonry and foundation, representing about half of the cost, were let out on contract and the remainder of the plant was constructed by the petitioner. The construction took about eight months and twenty-five or thirty men were employed who devoted their entire time to the work. The original plant was operated at full capacity during that period and the construction of the addition was supervised by petitioner's general superintendent. He received no other salary than his regular salary of $150 per month. Barclay, *2268 at the time, was managing the plant of the Barclay Chemical Co., and visited the plant three or four times during construction. T. H. Quinn assisted in supervision *1120 and remained at the plant throughout the period, devoting his entire time to the business of the petitioner. M. F. Quinn participated in the planning of, and inspected, the work and contracted for the masonry and materials. He also managed the business and looked after the bookkeeping. He received only his regular salary. The amount of time devoted by the officers and superintendent to the new addition can not be accurately determined and no capital charge was made therefor.
The petitioner had no cost-plus contracts.
For the year 1917 the respondent determined the income and profits-tax liability of the petitioner to be $218,537.74, and based the deduction from invested capital for 1918 and 1920 on said tax. The pro rata portion of such tax deducted from invested capital for 1918 was $119,746.70.
The income, invested capital, and profits tax of the petitioner and the per cent of its profits tax to net income, less $3,000, as determined by the respondent for 1918, are as follows:
| Net income (less $3,000) | $265,018.15 |
| Profits tax | 166,331.50 |
| Invested capital | 291,907.77 |
| Ratio of profits tax to net income | 62.8% |
*2269 OPINION.
STERNHAGEN: The first question for decision is whether as a matter of law and by virtue of the facts in evidence the petitioner is entitled to include in its statutory invested capital as defined in sections 325 and 326, Revenue Act of 1918, any amount as the value of its rights as assignee of the contract of June 21, 1912. Two witnesses testified for petitioner that in their opinion the contract was at the time of assignment and on March 1, 1913, worth $800,000, and another testified to his opinion of a value of $1,300,000. There are, however, facts in evidence which we think seriously impair the weight of these opinions.
The contract was made in June, 1912, by parties who on both sides were acting with full knowledge of the then known facts and were both apparently intelligently aware of the possibilities. After six months of negotiation they agreed upon terms as to price and other obligations, both having in contemplation the organization of petitioner, the construction of a plant, the precise use and purpose of the wood supply and the risks and hopes of the enterprise. Nothing occurred prior to March 1, 1913, which was not contemplated on June 21, 1912, to*2270 change the relative advantages of the parties under the contract or to justify the belief that the net rights of the Lackawanna Co. could be sold to a willing and intelligent buyer for a *1121 premium. It it could have been so sold or were fairly worth a substantial premium above the assumption of its contractual obligations, it may be questioned why the Lackawanna Co., acting for its stockholders, sone of whom had no interest in the Keystone Co., assigned the contract without realizing upon this asserted increment in the value of its rights.
The valuation asserted by the petitioner's witnesses is arrived at by attributing to the contract as assumed assurance of future profit of $3 or $4 to be derived from the manufacture and sale of each cord of wood supplied out of an assumed source of supply of 400,000 cords. It does not require expert intelligence or special experience in the manufacture of wood chemicals to perceive the fallacy of such valuation, even accepting it as fact that such assumed profits could be quite definitely foreseen. By such reasoning, the allocation of profits is confined to give value solely to the contract providing for the supply of one class of*2271 raw material. No part of the profit is allocated to plant or other investment, to say nothing of other supplies or expenditures. Thus a steel business might attribute its profits as it chose to give value to contracts for ore, coke or limestone, or a motor manufacturer to any one of the numerous supply contracts it might have. This would be clearly unsound. Granted that the reasonably certain prospect of future earnings might in a proper case be translated into a present worth, and assuming that such worth may be treated as a present asset, like, say, good will or going-concern value, there is no authority in precedent and we think none in reason for carrying the process beyond its effect on the business as a whole and into an allocated valuation of each contract or other factor used in producing the expected estimated gains. .
The opinion of the court in , does not compel a recognition of such a valuation merely because it is offered and because no countervailing witnesses have been brought forth to testify to the manifest unsoundness*2272 of its method. Opinions are at best a weak form of evidence, although in some esoteric matters they may constitute the only method of proof. Their weight can not be the equal of fact, and, unlike factual evidence, they involve the play of reason and can not be blindly adopted as truth. Valuation is notably a matter of opinion and the force of the opinion is derived from the care and ability used in forming it. Historical experience alone lends no necessary authority to an opinion; but only when coupled with mental ability to give it significance, and in matters of valuation, to appreciate the nature of the problem. Thus opinions as to value are in each instance not arbitrarily to be either rejected or accepted entirely, but are reasonably to be weighed with all the other evidence in accordance with the demonstrated qualifications *1122 of each witness to form an opinion. ; ; ; *2273 .
Nor can we accept the factors used in arriving at this valuation. To say that in 1912 and 1913 the profit would be at least $3 a cord was a speculation not supported by the then existing facts, for this plant had had no past experience and for the immediate future the profit per cord in 1913 was $1.65 and in 1914, 58 cents. Furthermore, the contract itself discloses a serious apprehension of a substantial risk, and it must be assumed that this was a factor embodied in its terms.
We are of opinion that the evidence taken altogether does not justify a finding that the petitioner's contract rights were when acquired in September, 1912, of a value above the obligations which petitioner assumed. Hence, there is nothing, as a matter of fact, which has been omitted from invested capital. Since the evidence shows and the petitioner agrees that the value on March 1, 1913, was no greater than when acquired in September, 1912, it follows that there is no value on the later date to be used as a basis for a depreciation deduction in 1918 and 1920.
Furthermore, there appears to be no support as a matter of law for including*2274 the contract rights in invested capital, even if they be treated as tangible property under the statute. They were not, and it is not contended that they were, paid in for stock or shares. The shares were issued at par for $250,000 cash paid in by the Quinn and Barclay families. The contract was at that time between the Norwich Co. and the Lackawanna Co., whose shares were owned by the Quinns and the Shermans and not at all by the Barclays. The separate identity of the petitioner from that of the Lackawanna Co. was expressly provided for and can not be ignored. Indeed, if it were to be ignored and the two treated as the same, all semblance of claim to include the contract in invested capital would disappear; because it is only by positing the transfer from one to the other after a value has sprung up that invested capital can be claimed to be affected. The mere existence of a bilateral contract upon promises would not ordinarily affect invested capital. It is therefore claimed that the value of the contract rights above the burden of its obligations would be a paid-in surplus and therefore within statutory invested capital under section 326(a)(3). But the contract was not an*2275 asset paid in by stockholders over and above the par value of their stock. The petitioner became a party to it by a valid assignment from another corporation which was not a stockholder, thus acquiring both the rights and obligations of the assignor. This is not paid-in surplus in the ordinary sense and we see no reason to suppose that it was *1123 within the term as used in the statute. . It is unlikely that Congress intended an evaluation of the rights and obligations of each taxpayer under its contracts so acquired, in order to determine surplus. See . The contract represented no investment either of the petitioner or its stockholders, and nothing which reasonably should be used in determining whether the ratio of its profits was greater or less than the standard prescribed by the statute to measure the profits tax. See .
In our opinion, therefore, the contract may not be included in invested capital and the respondent's determination excluding it is sustained.
The petitioner's next contention*2276 is that its 1917 taxes have been overstated in computing invested capital for 1918 and 1920. Although though 1917 taxes are not directly in issue here, petitioner says that in order to determine invested capital for 1918 and 1920 it is necessary to determine the correct tax for 1917, and that such 1917 tax has not been correctly determined because in computing taxable net income for 1917 no deduction was allowed for exhaustion of the aforesaid wood supply contract of 1912 based upon its value on March 1, 1913. Whatever may be the merits of the theory generally that tax liabilities for years otherwise not before us for definitive determination are nevertheless in all respects open for consideration because of their effect upon invested capital in later years, the tax for which is under adjudication, we need not pass upon such theory here, because we have held that in fact the petitioner's contract rights had on March 1, 1913, no fair market value. Hence, as in 1918 and 1920, there was no basis for exhaustion thereof in 1917 and no necessary change in income or the resulting tax. Upon this point respondent's determination is sustained.
The petitioner's last claim is that the facts*2277 shown by the evidence, which are in substance stated in the foregoing findings, establish such an abnormal condition of capital or income as under section 327(d) to entitle petitioner to special assessment under section 328, the amount of which is to be later determined under Rule 62. We are of opinion that the conditions are not within the special assessment sections. We can not say that the amount of the salaries paid, the prewar earnings, the exclusion of the contract from invested capital or its approaching end through complete performance, the relative amount of its income in the taxable years, or the method of accounting for the 1915 addition to its plant, taken separately or together, are abnormal conditions resulting in exceptional hardship. The respondent's denial of special assessment is sustained.
Judgment will be entered under Rule 50.